The stock market is an integral part of the American economy. In addition to being a source of funds for new and growing businesses, the stock market provides an avenue for average Americans to participate as owners in successful enterprises — an opportunity historically limited to those with significant influence or fortunes. Yet, almost half (45%) of Americans do not have any ownership of individual stocks or in stock market funds, such as 401(k) or IRA plans, according to a 2020 Gallup Report.
Paradoxically, many Americans are increasing their savings. According to Bank of America, three out of four millennials are saving cash, with one out of four having $100,000 or more in a savings account. Despite their capacity to invest in the stock market, many savers prefer to stay in cash or in low-return debt instruments. Their decision to avoid equity investments could mean that their retirement funds will end up hundreds of thousands of dollars short by the time they retire.
Many people claim their aversion to common stocks is due to the 2007-2009 financial crisis that saw the S&P 500 fall from 1471.49 to 683.38, slicing retirement savings and investment portfolios in half. Such caution ignores the subsequent climb of the index to 2924.59 by October 1, 2018, more than four times its value in 2009. Also, a historical comparison by the Vanguard Group found that a portfolio of 100% equities almost doubled the return (10.3%) of a portfolio of 100% bonds (5.4%), even though the number of years with a loss was higher for stocks than for bonds (25 of 92 years versus 14 of 92 years).
Whether your personal financial goal is to become a billionaire or build a nest egg to support a comfortable retirement, the keys to capital growth are time, return on investment, and compounding gains. Buying and holding assets — also called “value investing” — as part of a long-term investment strategy is the surest way to achieve significant financial success. To help determine whether or not it’s right for you, let’s take a deeper look at what buy-and-hold investing is, and its pros and cons.
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Preparing for Investing in the Stock Market
The first step in determining whether or not the buy-and-hold investing strategy is right for you is to ensure that you’re prepared for investing in general. For instance, each potential stock investor should understand that:
- Investment Objectives Vary According to Age and Circumstances. Young investors may pursue an aggressive, higher-risk investment strategy with the knowledge that they have years ahead to overcome any mistakes. Older investors nearing retirement would be unwise to use an investment philosophy that might decimate their principal.
- The Level of Reward Typically Reflects the Level of Risk Assumed. Investment profits are never guaranteed. So, investors must accept some risk to reach their long-term financial goals. Owning a bond is vastly different than holding a share of common stock. Owning shares of different companies operating in various industries during different times have varying degrees of risk.
- Successful Investing Is Not Passive. Although luck plays a role in short-term results, the intrinsic value of a company is established over years of consistent performance. Successful buy-and-hold investors continually improve their investigative skills and consistently monitor factors that might affect the value of their investment — the economy, government regulations, potential competitors, industry news, and company reports.
- You Are the Biggest Impediment to Your Investment Success. Emotions play a dominant role in our decision-making process. Perhaps history’s greatest market investor, Warren Buffett, has developed and practices investment techniques to minimize the powers of fear and greed that motivate all of us.
Reasons to Implement a Buy-and-Hold Investment Strategy
The advantage of a buy-and-hold strategy is the ability to apply logic rather than emotion to the stock market. There is no need to “time the market,” a task most financial professionals agree is impossible. Research is not focused on the interpretations of price movements or other attempts to identify the mood of the market. Investment decisions are based upon real fundamental data and clear logic.
The validity of a long-term investment strategy has been repeatedly confirmed by research, including a five-year study of more than 66,000 households with accounts at a large discount brokerage firm. The conclusion by professors Brad Barber and Terrance Odean of the University of California, Davis business school is “trading is hazardous to your wealth.”
Critics of buy-and-hold presume that practitioners of the strategy rarely review their positions until months or years after their purchase, taking a passive investing approach.
That presumption is wrong.
A long-term investor, like the owner of any business, will be aware of events or changes that might affect the ability of his company to maintain its competitive advantage. While there may be some indication that buy-and-hold investments are passive investments, the most successful practitioners of this investing strategy are relatively active.
All investors should be aware of the economy as well as government and geopolitical activities; the former can affect the buying power of potential customers while the latter can add or erase legal protection with the stroke of a pen. World events can increase or diminish trade barriers and new inventions can render popular products obsolete overnight.
The time to sell a company or a stock is when the investor loses faith in management’s ability to extend a competitive edge. This decision should never be made based on short-term fluctuations in stock prices driven by fear and greed.
Capital Gains Tax Benefits
The buy-and-hold investing strategy not only provides investors with an approach to the stock market that’s proven to be advantageous throughout history, it offers capital gains tax benefits.
When an investor sells a stock, the resulting profits or losses are known as capital gains or capital losses, respectively. On short term investments, capital gains are taxed as ordinary income. When investments are held for longer than one year, capital gains generated from those investments are taxed at the long-term capital gains tax rate, which ranges from 0% to 20% depending on the amount of money earned from the sale of your securities. With current income tax rates ranging from 10% to 38%, long-term capital gains tax rates offer quite the discount.
Criticisms of the Buy-and-Hold Investing Strategy
Every rose has its thorns and every investing strategy will have its critics. Critics of a buy-and-hold stock strategy complain that only a few with strong stomachs and steel resolve can emotionally handle the volatility of the market. In other words, even resolute investors are tested any time there’s a bear market similar to the nosedives seen in the stock market in 2008 and 2020. No stock is immune from the gyrations that occur in emotional markets, including some of the most popular growth companies:
- Microsoft fell more than 12% on July 18, 2013, to $31.10, wiping out more than $36 billion in market value.
- Apple fell more than 11% in 2016 from $105.48 to $93.74 in a single week during 2016.
- Amazon, a publicly-traded company since 1997, suffered a 15% drop in value on a single day in January 2016 after reporting lower-than-anticipated earnings.
Unwillingness to Avoid Losses
The extreme volatility of modern markets prompts many investment advisors to chide investors using buy-and-hold market strategies, recommending instead a variety of timing strategies that they support. Consider the following possible arguments for more aggressive investing tactics:
- It may be impossible for your investment portfolio to survive a series of severe or sudden losses. So instead, it may be best to implement a more tactical, less risky investment strategy.
- Markets do not increase each and every year, so by not taking into consideration the possibility of severe losses, you may be putting your portfolio at risk of getting into an unrecoverable situation.
- If you spend your entire life waiting for returns that may never come through the buy-and-hold strategy, you put yourself at risk of never seeing the benefits of your investments.
The Value Investor’s Response
Whether such criticism is justified depends on your perspective of time. For example, markets may very well be irrational in the short term and rational in the long term. It’s impossible to control or predict how long any particular fluctuation or change in the stock market will last. So, instead of focusing on short-term, temperamental fluctuations, it’s best to focus on longer holding periods lasting anywhere from 10 to 20 years at a time.
Skeptics of a buy-and-hold market approach would be wise to remember the opinion of Wall Street Journal columnist Jason Zweig, who wrote during the depths of the 2009 market decline that in order for buy-and-hold to be found as a successful long-term investing strategy, you must endure a prolonged amount of time — even decades or generations — for buy-and-hold to emerge as the stronger investment.
The Philosophy Behind the Buy-and-Hold Strategy
To get a clear understanding of what the buy-and-hold strategy is, it’s helpful to look at the philosophy behind it. Warren Buffett, considered by many to be the most successful investor of all time, is eagerly sought for his advice. Buffett has explained that his investment approach requires the same considerations you would make if you were buying an entire operating business. The chairman of Berkshire Hathaway recognizes that shares of common stock represent ownership in a business, whether one share or 100,000 shares. Each shareholder shares in profits and losses in a direct ratio of his percentage of ownership in the company.
Buffett’s investment horizon is clearly long term, often quoted as saying “If you aren’t thinking about owning a stock for 10 years, don’t even think about owning it for 10 minutes.” He has stated that when he buys a stock, he intends to own it forever. Once Buffett has determined that a company meets his criteria, he buys it without being overly concerned about the price of the shares. In his 1989 chairman’s letter, Buffett wrote to his shareholders, “it’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
A value investor intending to hold a company for a long time is not concerned about short-term prices. Even when prices decline, value investors see an opportunity to add to their positions at a discount. Patience is a virtue of the value investor, allowing them to overlook the “noise” of short-term volatility and avoiding the temptation to compromise their investment standards.
Buy-and-hold investors do not rely on complex technical analyses or popular opinion to guide their investment decisions. Instead, they prefer companies and industries whose markets, operations, and competitive advantage are easily discernible. Like Buffett, former manager of Fidelity Magellan Fund Peter Lynch recommends avoiding investments you don’t understand. In his book “Beating the Street,” Lynch advises never to invest in an idea that you can’t illustrate with a crayon.
Why Buy-and-Hold Investing Works
Lasting value is rarely achievable in the short-term, especially in the business world. Plans to improve profitability including new marketing strategies, improved employee engagement, or measures to streamline performance require time and effort to complete. The passage of time allows feedback and opportunities for managers to evaluate and hone competitive advantage into sustainable long-term barriers, ultimately producing a steady, growing stream of profits.
Intrinsic value, sometimes referred to as inherent value in the stock market, is the discounted value of a company’s projected cash flows, justified by available facts. All things being equal, a business that historically grows profits at 10% annually would have a higher intrinsic value than a company with a historical growth rate of 5%.
In the short-term, prices of an asset are driven by the emotions of greed and fear — what speculator Jesse Livermore called the “mood of the market.” A crowd mentality, driven by rumors and minimal investigation, triggers wide swings in market prices (volatility) and periods of irrationality. As a consequence, manias such as the rush to buy dot-com stocks of the 1990s or illogical declines in well-managed companies create disparities between the price of the security and its intrinsic value.
Unfortunately, the error rate of forecasting stock price trends is high. There are no reputable studies that suggest anyone — fortune tellers, astrologers, market mavens, or chartists — has successfully and consistently predicted short-term price movements.
Value investors should not be concerned about the prices of their holdings in the short-term but should try to determine whether a prospective company has long-term market opportunities, a competitive edge in the marketplace, and a management team capable of delivering a future stream of growing profits.
Outcomes of a Buy-and-Hold Strategy
The financial rewards for those who can successfully implement a buy-and-hold strategy are enormous. The market value of shares acquired on or immediately after an initial public offering and held long-term are one indication of the validity of long-term holding strategy. Consider the returns for investors who purchased stock in the initial public offerings of the following companies and continue to hold them today:
- Amazon. An investor who bought 100 shares of the online retailer at the initial public offering of $18 in 1997 would have 1,200 shares — after three stock splits in 1998 and 1999 according to StockSplitHistory.com — by November 2020, with an approximate value of $3.8 million.
- Google. A single share of Google on its offering on August 19, 2004, at a cost of $85, after two stock splits, had a value of more than $3,500 by November 2020.
- Facebook. The social media giant went public on May 18, 2012, at $38 per share. The shares were valued at more than $270 in November 2020.
Another measure of careful selection and holding long-term investments is the track record of Buffett’s Berkshire Hathaway portfolio. While the portfolio contains stocks of more than 50 companies, a few are especially notable for the length they have been held and their increase in value:
- American Express Company. Buffett bought his initial position in the company in 1960 for a total cost of $1.28 billion. Adjusted for a stock split, he currently owns 151.6 million shares with a market value of more than $15.8 billion.
- Apple. Berkshire Hathaway began acquiring shares in Apple in 2016 and now owns more than $91 billion in stock — more than 40% of the company. According to an article in Fortune, Buffett explained that he bought shares due to their “intelligence with the capital they deploy, but more importantly, the value of their ecosystem and how permanent that ecosystem could be.”
- Coca-Cola Company. He started buying the stock in the late 1980s and had 200 million shares with a cost basis of $1.2 billion in 1995. He now has 400 million shares through stock splits, with a value of $18 billion.
- M&T Bank. In 1999, Berkshire Hathaway held more than 4.5 million shares with a total value of approximately $417.74 million.
- Wells Fargo & Company. Buffett acquired shares of the bank in 1995 for a cost of $423.7 million. He currently owns more than 136.34 million shares with a market value greater than $3.2 billion.
However, the ability to select only companies most likely to succeed and then keep them for years or even decades is rare, even for an investor of Buffett’s prowess. As Berkshire Hathaway’s investment portfolio has grown larger, the results of individual companies are diluted, as are the opportunities to invest hundreds of millions of dollars annually.
Even the most noted investors make mistakes. Buffett has publicly admitted several poor decisions including his 1993 purchase of Dexter Shoes, his position in Energy Futures Holdings, and his decision not to buy shares in Amazon and Google. Some have suggested that Buffett has become a victim of his own success and can no longer meet the expectations of his admirers. Nevertheless, his track record over decades is a tangible testimony to his accomplishments and the validity of his strategy.
Many value investors reduce the impact of short-term price movements when buying their targeted stocks by using a technique called dollar-cost averaging. Simply stated, it is the practice of buying or selling a fixed dollar amount or percentage of a security on a regular schedule, regardless of stock price. Also called a “constant dollar plan,” dollar-cost averaging results in more shares being purchased when the stock price is low and fewer when the price is high. As a consequence of the technique, an investor reduces the risk of buying at the top or selling at the bottom.
For example, suppose you want to invest $3,000 in the stock of a company. You may decide to dollar-cost average by investing $1,000 for three consecutive months, instead of the total $3,000 in a single purchase. Consider three different scenarios:
- Falling Prices. Say the price of the stock drops from $10 in the first month to $8 the second month and $6 the third month. In this scenario, you would acquire 100 shares in the first month ($1,000/$10), 125 shares the second month ($1,000/$8), and 166 shares the third month ($1,000/$6). At the end of the period, you would own 391 shares at $6 per share with a total value of $2,346. You would end up with a loss of $654, but if you had purchased 300 shares for $10 per share, your loss three months later would have been $1,200. Dollar-cost averaging reduces losses in a falling market.
- Rising Prices. Imagine the price of the stock rises from $10 in the first month to $12 the second month, and $14 the third month. In this case, you would acquire 100 shares in the first month ($1,000/$10), 83 shares the second month ($1,000/$12), and 71 shares the third month ($1,000/$14). At the end of the period, you would own 254 shares worth $14 per share with a total value of $3,556. You would have an unrealized gain of $556. If you had purchased 300 shares for $10 per share initially, your gain three months later would be $1,200. In this case, dollar-cost averaging would reduce your gain by $644, although you remain in a profitable position. In a continually rising market, dollar-cost averaging reduces potential profits.
- Fluctuating Prices. Now suppose the price of the stock starts at $10 in the first month, falls to $8 the second month, and returns to $10 in the third month. In this example, you would acquire 100 shares in the first month ($1,000/$10), 125 shares the second month ($1,000/$8), and 100 shares the third month ($1,000/$10). At the end of the period, you would own 325 shares at $10 per share with a total value of $3,250. You would end up with a gain of $250. If you had purchased 300 shares for $10 per share initially, you would have neither profit nor loss. In a constantly fluctuating market, dollar-cost averaging is likely to either reduce potential losses or produce gains.
Dollar-cost averaging is a technique to reduce the risks of fluctuating prices. It is often used to fund IRA investments when contributions are deducted each payroll period. This investing strategy can protect you against market fluctuations and downside risk.
Application to Mutual-Fund and Index Investing
A long-term investment strategy is based on the stability and duration of ownership of each company you invest in. Data gathering and analysis don’t come naturally to most people, requiring time, knowledge, and effort to identify and evaluate each element of your portfolio. As a consequence, many investors reject the buy-and-hold strategy for selecting individual stocks as impractical or not suited to their lifestyle.
An inability to implement a long-term, individual stock buy-and-hold strategy does not preclude buying and holding equities for higher returns. Many investors purchase mutual funds or index funds with portfolios of managed equity investments. Buying and holding broad-market index funds or quality mutual funds over the long term can be a perfectly effective strategy.
In 2007, Buffett bet $1 million dollars that an S&P 500 index fund could outperform hedge funds over a 10-year period. Ted Seides, president of Protege Partners, an investment firm that invested in hedge funds, took the opposing side of the bet. Buffett won his wager and contributed his winnings to charity.
In 2018, Buffett advised investors who are not inclined to spend the time to investigate individual investments for long-term investment to consistently buy into a low-cost S&P 500 index fund, saying, “that makes the most sense practically all of the time.”
Real Estate Investments Offer a Buy-and-Hold Opportunity Outside of the Stock Market
Real estate investments are a compelling buy-and-hold opportunity for investors who are unwilling to participate in the stock market. When investing in real estate as a buy-and-hold investment, there are a few strategies worth considering:
- Buy and Rent. The most common real estate investment strategy is the buy-and-rent strategy. This strategy includes buying a house or commercial building (this can be done with ease through Roofstock) and renting it to tenants to generate consistent income.
- Buy Land. Land is one asset that simply can’t be made again. With a limited supply, as the population grows, vacant or raw land is known to grow in value, making it a strong long-term investment opportunity. Land can be rented to farmers, mined for natural resources such as minerals or lumber, or flipped for a profit.
- Invest In REITs. Real estate investment trusts (REITs) are funds whose holdings are held in real estate. Real estate investment trusts through a company like Fundrise give investors access to real estate investments who have little knowledge of the real estate industry or a lack of the capital needed to purchase real estate elsewhere.
In a world where few things are certain, saving for the future is a necessity. Fortunately, America’s economic outlook over the long term is strong. Our progress has been fueled by a financial system that encourages risk-taking and innovation by rewarding those who participate as shareholders of the companies who deliver goods and services to domestic and foreign consumers alike.
The difference between investing in equity stocks versus investing in fixed-income securities is dramatic over the long term, the latter delivering about half of the performance of the former. Consider the following:
- Investor A. This 30-year-old invests $500 monthly in fixed-income securities ($222,000 total) with an average annual return of 5.4% — the average fixed-income return for the last 92 years. Investor A will have a balance of $702,675 at retirement age 67. Conversion of the principal into an annuity at retirement through Charles Schwab would provide a monthly income of $4,387 for life.
- Investor B. This 30-year-old invests the same $500 monthly in equities, such as stocks and low-cost index funds and mutual funds, and earns an average annual return of 10.3% — the average yearly return from the stock market over the past 92 years. Investor B’s ending balance of $2,352,229 converted into a similar annuity as Investor A would provide a lifetime monthly benefit of $14,694, more than 330% greater than the fixed-income investor.
Investing in well-managed stocks and holding them for an extended period of time — with proper monitoring — has proven to be the superior way to build wealth and prepare for the uncertainties of age and time. Plus, the earlier you start, the more likely you will be pleased with the outcome.